SEC accuses Goldman Sachs of defrauding investors

The new Goldman Sachs world headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010, is shown. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)
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The new Goldman Sachs world headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010, is shown. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)
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People walk in the lobby of the Goldman Sachs headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)— AP

People walk in the lobby of the Goldman Sachs headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)
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People walk past Julie Mehretu's "Mural" in the lobby of the Goldman Sachs headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)— AP

People walk past Julie Mehretu's "Mural" in the lobby of the Goldman Sachs headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)
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FILE - In this Feb. 11, 2009 file photo, Goldman Sachs & Co. Chief Executive Officer Lloyd Blankfein, testifies on Capitol Hill in Washington before the House Financial Services Committee. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Manuel Balce Ceneta, file)
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As security looks on, people enter the Goldman Sachs headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)— AP

As security looks on, people enter the Goldman Sachs headquarters in the Lower Manhattan area of New York, Friday, April 16, 2010. The government has accused Goldman Sachs & Co. of defrauding investors by failing to disclose conflicts of interest in mortgage investments it sold as the housing market was faltering. (AP Photo/Diane Bondareff)
/ AP

WASHINGTON 
The government on Friday accused Wall Street's most powerful firm of fraud, saying Goldman Sachs & Co. sold mortgage investments without telling the buyers that the securities were crafted with input from a client who was betting on them to fail.

And fail they did. The securities cost investors close to $1 billion while helping Goldman client Paulson & Co., a hedge fund, capitalize on the housing bust. The Goldman executive accused of shepherding the deal allegedly boasted about the "exotic trades" he created "without necessarily understanding all of the implications of those monstrosities!!!"

The civil charges filed by the Securities and Exchange Commission are the government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession.

The news sent Goldman Sachs shares and the stock market reeling as the SEC said other financial deals related to the meltdown continue to be investigated. It was a blow to the reputation of a financial giant that had emerged relatively unscathed from the economic crisis.

Goldman Sachs denied the allegations. In a statement, it called the SEC's charges "completely unfounded in law and fact" and said it will contest them.

The SEC is seeking to recoup the money lost by investors and impose unspecified civil fines against Goldman Sachs and the executive, Fabrice Tourre. The SEC could enter into settlement negotiations over the amount if Goldman changed its stance and decided not to fight the charges in a trial.

The SEC said Paulson paid Goldman roughly $15 million in 2007 to devise an investment tied to mortgage-related securities that the hedge fund viewed as likely to decline in value. Separately, Paulson took out a form of insurance that allowed it to make a huge profit when those securities' value plunged.

The fraud allegations focus on how Goldman sold the securities. Goldman told investors that a third party, ACA Management LLC, had selected the pools of subprime mortgages it used to create the securities. The securities are known as synthetic collateralized debt obligations.

The SEC alleges that Goldman misled investors by failing to disclose that Paulson & Co. also played a role in selecting the mortgage pools and stood to profit from their decline in value. Two European banks that bought the securities lost nearly $1 billion, the SEC said.

"Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party," SEC Enforcement Director Robert Khuzami said in a statement.

But Goldman said in a statement that it never mischaracterized Paulson's strategy in the transaction. It added that it wasn't obliged to "disclose the identities of a buyer to a seller and vice versa."

The charges name only Goldman Sachs and Tourre, who was a vice president in his late 20s when the alleged fraud was orchestrated in 2007. Tourre, the SEC said, boasted to a friend that he was able to put such deals together as the mortgage market was unraveling in early 2007.